Steep Sell-off Makes Chinese Equities More Attractive

Barron's released an article on September 29th entitled "It's Time to Revisit Emerging Markets." I'll get more into their rationale in a bit, but the gist is that EM stocks (especially in China and Asia), have fallen so much while maintaining positive debt ratios, that they are looking like good buys since they are quite cheap.

The article cites that "Brazil is off 23%, Mexico 13%, Russia 43%, China 16%, and Korea 12%… since July." While in reality, after the turbulence yesterday, Emerginvest's heat map cites that it is even more egregious: in the last quarter, Brazil is down 25%, Mexico 18.9%, Russia 51%, China 22%, etc. compared to the recent downturn where the U.S. is down by 16.4% for the quarter.

Ironically however, that only strengthens the article's argument. It describes how Mohammed El-Erian, the co-CIO of PIMCO (who also happens to be an emerging markets expert), is still quite optimistic about emerging markets returns. He states: "Technically, you'll see an even sharper rally in emerging markets than U.S. equities. I'd at this point be looking to buy the [MSCI Emerging Markets] index" (EEM). The article fully admits that emerging markets will be affected, however it states that Morgan Stanley believes it will slow to somewhere around 7% growth in the first part of '09.

The article cited how the MSCI index was trading at a 10.9-x multiple of trailing earnings, the lowest valuation of the last 7 years. In addition, it discusses how projections of the continued growth of emerging markets (contrasted with developed markets attempting to dig themselves out of the credit crisis for the foreseeable future) compliments the cheap prices: "David Fisher, chairman of Capital Group, recently said he expects 70% of the world's growth over the next two decades to come from the emerging markets. At the moment, they account for just 11% of the world's stock-market value, even though JPMorgan Chase reckons they'll account for 28% of the global economy next year."

It advises that many (if not all) of the emerging market opportunities look interesting, yet points to Asia (ADRA) and China (FXI) specifically. One method it used to select attractive indexes/countries was to consider their loan-to-deposit ratio. They say if it's "over 100%, there's a very high probability the whole country will need to delever." Using this metric it picks out Hong Kong (57.4%), China (65%), Indonesia (72%), the Philippines (73%), Malaysia (74%), and Taiwan (78%), yet specifically points to China (how it dropped due to inflation fears, but those have diminished and might expect a rebound). It singles out China Mobile (CHL) as an example of a company which has dropped significantly (43%) of its share price, but has continued to grow revenue and margins.

Underlying this argument is that since many of the debt ratios of Asian countries in particular (in addition to some strong growth prospects), they won't have the same credit problems internally as many developed markets will. In addition, with Monday's heavy downswing, they might look like attractive options.

Disclosure: No positions held.

Comments

[Larry House:]

Looking cheap and being cheap are two different things. I have a position in a China fund, which I will hold through thick and thin. I am afraid, however, that it will be thin to thinner for some time to come. I will put more in EM, but if the world economy continues to spasm, EM haven't bottomed out yet.

2008 Oct 07 12:49 PM

[20smoney:]

Looking 10+ years out, I think China is a fantastic investment... Im buying more FXI at current levels.

2008 Oct 07 02:53 PM

[jack chambers:]

China and all emerging markets have yet to be priced for a deep and long recession in the US and EU. These markets could easily drop 50% from here if we have a deep recession and lower still if the world has a depression. Only a idiot would look for a bottom at these levels.

2008 Oct 07 08:51 PM

[Urbane Gori...:]

I was just listening to a Bloomberg audiocast with Loiuse Yamada.. She's a technician who has been pretty much right on the trends. About a month ago, she was on fast Money and called the probable drop too 10,000. The audiocast was (unfortunately) just a couple of days ago and she was voicing her concerns that the market might drop below 10,000 and then to 9K... Doesn't really look like the time to be buying anything... jegan

2008 Oct 07 09:30 PM